Student loans reform is a leap into the unknown

At the end of February, the government announced the most significant reform to the student loans system in England since at least 2012. The central planks of the reform are a lower earnings threshold for student loan repayments (cut to £25,000 and then frozen until 2026–27); a change in the future uprating of the earnings threshold from the rate of average earnings growth to the rate of RPI inflation; an extension of the repayment period from 30 to 40 years; and a cut in the maximum interest rate on student loans to the rate of RPI inflation (from a maximum rate of RPI inflation plus 3%). The new system will apply in full from the 2023 university entry cohort onwards, but the 2012 to 2022 entry cohorts (‘Plan 2 borrowers’) will also see significant changes.

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Our initial analysis showed that:

• The announced reform package will transform the student loans system. Despite their name, pre-reform student loans mostly functioned as a graduate tax: a large majority of graduates were set to pay back 9% of their earnings above the repayment threshold for 30 years, irrespective of their student loan balance. Under the new system, this is no longer true: more than 70% of graduates can expect to repay in full and will receive no taxpayer-financed write-off of their loans.
• Graduates with lower-middling earnings will be hit the most by the changes with a lifetime loss of around £30,000. These earners enjoyed large taxpayer subsidies before the reform, but will have to pay back a much larger share of their loans under the new system.
• The highest-earning graduates will repay around £20,000 less as a result of the lower interest rate. These graduates would largely have paid back their loans in full even under the pre-reform system. For them, the lower interest rate translates into lower repayments overall, whereas the lower repayment threshold merely causes them to pay off their loans more quickly.
• The long-run taxpayer savings as a result of changes announced at the end of February is around £2.3 billion. The short-run impact on the budget deficit will be much larger at around £6.3 billion for the 2023 cohort. This is due to an accounting quirk.
• The system will also become substantially less generous for middle-earning graduates from the 2012–22 starting cohorts. These students are affected nearly as much by changes in repayment thresholds as students from the 2023 cohort onwards, but do not benefit from lower interest rates. Compared with the pre-reform system, 2022 starters stand to lose around £20,000.

In this briefing note, we present a more detailed analysis of the effects of the reform on students and the taxpayer – both on the 2012–22 entry cohorts and on entry cohorts from 2023 onwards – updated using the latest economic forecasts from the Office for Budget Responsibility. Throughout, we will emphasise the very large amount of uncertainty regarding the consequences of the reform. It is not clear how the announced changes will affect the behaviour of prospective students. And while we can say roughly who will gain and who will lose financially from the reform, it is hard to say exactly by how much. This is primarily because the impact crucially depends on what the earnings of current young people will be decades from now, which we cannot hope to predict precisely.

Key findings

1. The results of our initial analysis hold up when we update our projections using the latest economic forecasts from the Office for Budget Responsibility and new data on graduate earnings. As a result of new OBR interest rate forecasts, we are now able to model the operation of the interest rate cap on student loans. However, all of these updates only have very small effects on the estimated impact of the reforms.
2. The reform makes the higher education funding system in England even more of an outlier internationally. Even before the reform, England relied less on public funds for funding higher education than comparable countries. It is unpredictable how the low public subsidy will affect prospective students’ choices.
3. The change in threshold indexing from average earnings growth to RPI alone is likely to cost middle-earning graduates from the 2022 and 2023 cohorts more than £10,000 over their lifetimes. For the taxpayer, this change alone is set to save substantially more than £2 billion in undiscounted real terms. It is somewhat concerning that such a significant change was not mentioned at all in the press materials announcing the reforms.
4. Overall, the highest-earning borrowers will be better off under the system from 2023 onwards, and low-earning borrowers will be better off under the 2022 system. For 2022 school leavers, this means that incentives regarding whether to take a gap year will crucially depend on their expected future earnings.
5. In the medium term, the reforms will result in graduates from the 2023 entry cohort repaying around £750 a year more from 2027–28 (when they typically start repaying loans) if earning more than £33,900. Graduates from earlier cohorts since 2012 earning more than £32,900 in 2026–27 (when the 2022 cohort will typically start repaying) will have to pay around £400 more than under the pre-reform system.
6. The taxpayer will likely save more on loans to the 2022 cohort than on cohorts from 2023 onwards as a result of policy changes announced this year. This is because the cohorts from 2023 onwards will enjoy a lower interest rate on student loans, which will be costly for the taxpayer. In undiscounted terms, the reforms will likely cut the taxpayer cost by three-quarters for the 2022 cohort and by half for the 2023 cohort.
7. Despite this, the short-term reduction in government borrowing from the reforms will be much larger for cohorts from 2023 onwards than for the 2012–22 cohorts. This is entirely due to the treatment of changes in the student loan interest rate in the national accounts. Paradoxically, lowering student loan interest rates lowers the initial cost of extending student loans, as it means a larger share of loans will be repaid with interest.
8. The government’s policy choices have made the taxpayer cost of the student loans system less predictable. The change in the indexation of the repayment threshold ties the cost of loans more strongly to future earnings growth. As a result of the extension of the repayment term, graduate earnings in 40 years’ time will matter for student loans, and these earnings are even harder to predict today than earnings in 30 years’ time. The freeze in the repayment threshold means that the future cost of loans will hinge on the unpredictable path of inflation in the next few years.

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